Slowing China Economy Raises Questions About Policy

A sharp downturn in manufacturing activity in China is a warning sign to the government not to move too quickly to tighten monetary conditions, says HSBC’s chief China economist, Qu Hongbin.

HSBC and Markit released data Thursday that show conditions in China’s manufacturing sector deteriorated for the first time in six months in January. The HSBC flash China purchasing managers index stood at 49.6, below the 50 mark that separates expansion from contraction.

For Mr. Qu, the data show the dangers of China’s moves to tighten credit due to its concerns over off-balance-sheet borrowing by local governments.

A slowdown in investment in sectors that local administrations favor, like property and infrastructure, is feeding through to lower orders in the manufacturing sector. Meanwhile, export orders haven’t yet picked up due to tepid consumer demand in the U.S and Europe.

Mr. Qu said China needs to get a handle on its huge shadow banking sector to avoid messy defaults. But he pointed out that policy makers need to do this without tightening credit for companies in the manufacturing sector, given that inflation remains low across the economy.

The risk of a general rise in interest rates is a slowdown similar to the one China experienced a year ago. That gave authorities the chills and led to a mini fiscal stimulus that helped restore growth later in 2013, Mr. Qu said.

“They should be aware of the risks,” he said. “If I were a policy maker, I’d try to strike a balance.”

The HSBC data, an early indication of the final survey that comes out at the end of January, was worse than many commentators expected. A sub-index that charts new orders turned negative, suggesting weaker local demand. The pace of decline in new export orders accelerated. Employment conditions also worsened.

The data come after deteriorating economic conditions in the final quarter of 2013, when growth was 7.7% from a year earlier. Industrial production was up 9.7% on year in December, against 10.3% growth in October. Investment growth numbers also fell.

Some observers say the weaker PMI data could be partially explained by slower factory activity as people begin to wind down ahead of the Chinese New Year, which this year falls on Jan. 31.

“We are reluctant to read too deeply into this number,” due to distortions around Chinese New Year, said Bill Adams, a U.S.-based economist with PNC Financial Services Group. “While Chinese policy makers have been tapping the brakes on the domestic side of the economy, stronger growth in advanced economies should be boosting demand for Chinese exports.”

Mr. Qu says there are potentially some new year-related distortions to the numbers. HSBC and Markit seasonally adjust the data, but as Chinese New Year moves every year depending on the lunar calendar, these adjustments can be imprecise.

But he believes the domestic economy is definitely showing signs of weakness. “This is just an initial sign of this softness.”